Mortgaging and the Financial Crisis
The intervention by the government in 1932 was indeed a desirable step, as it had the important net effect of increasing home ownership within the country, by availing more funds against which mortgages could be allowed. The intervention of creating the FHLB and an insurance fund through the NHA against which lenders previously unqualified for loans, could take up mortgages. Further, the intervention by the government served to eliminate the previously existing situation in which loans were being defaulted to, due to their short term nature, the fact that the loan-to-value ratios were very small, as well as the fact that most were non amortizing, making affordability an issue. The creation of Fannie Mae in 1938, further served to improve the situation of homeownership, as it served as a facilitator for market mortgages that were secondary, as well as allowed private lenders to lend more, especially within the secondary market, providing a basis for more high risk loans previously shunned by financial institutions. The rise of Ginnie Mae came about due to the move by the government to change FHA mortgages previously insured by the government to a corporation that is wholly government owned. The guarantees provided by Ginnie Mae, essentially allowed mortgage lenders to not only get better prices for loans they issued, but also to use any proceeds they make to further avail new mortgages to customers. The rise of Freddie Mac allowed the government to infuse yet more funds into the mortgage industry. The net effect of the three organizations was that mortgaging became more risky, as mortgaging institutions engaged in riskier lending against the backdrop of funds from the government. The cost of mortgaging was however reduced, and lending became more widespread.
The Community Reinvestment Act was passed in order to compel banks to engage in lending even to neighborhoods that had low income earners. The Mortgage Disclosure Act was on the other hand, aimed at establishing to the public, whether or not the financial institutions were serving the interests of communities to which they belonged, by compelling these institutions to provide loan data on their lending patterns to the public. The Depository Institution Deregulation and Monetary Control Act, was essentially meant to gradually eliminate existing limitations on payable interests hence authorizing interest bearing accounts. The final Act; Housing and Community Development Act, served to amend section 8 of the housing act, allowing the government to assist low income households in paying their rents. These acts served to expand homeownership by making it easier to become a homeowner. They attempted to provide greater means through which to become a homeowner.
The subprime mortgage loans did contribute to the housing bubble, with the bubble bursting as a result of a lack of sufficient financial cushion to support the massive defaults in payments, as well as losses that came as a result of these defaults. The rise in foreclosures and subprime mortgage delinquencies, coupled with a decline in the securities that were used to back up these mortgages and loans, effectively eliminating the necessary cushions for defaulters, and the rise of the 2008 financial crisis. Borrowers therefore, lost their houses, as the lenders no longer had securities against which to fall back on in the case of defaulters. For loan originators, the loss of value that resulted from the crisis, led to losses that were essentially uninsured, with no existing cushion. The mortgage crisis, as already mentioned, led to massive value losses for mortgage backed securities (MBS), as their value was essentially hinged on housing prices and mortgage payments, making the decline in the former, and significant defaults in the latter a huge blow to MBSs.
Federal legislation and the establishment of bodies such as Ginnie Mae, Fannie Mae, and Freddie Mac, encouraged CFC to adopt a more robust high risk strategy that would have otherwise not been adopted. The government’s encouragement of subprime mortgages did have a significant impact on the company’s loan originations, as the more attractive but riskier terms attracted more borrowers, and mortgage undertakings. The housing boom, further served to encourage more and more Americans to take up mortgages, serving to further drive up the prices of housing, essentially multiplying the risk associated with the undertakings the CFC engaged in.
Housing boom and the growth in origination of subprime mortgages brought huge success for Countywide Financial Corporation’s. The company attracted huge numbers of clients who felt that the idea of home loans was attractive. Most customers that arose after the introduction of the housing boom were those that could not access traditional loans because of they had less than stellar credit history. The company placed high interests due to the risk of the loans they offered and these marked the high growth rate during the initial company years. From the financial ratios attained the company had a consistent growth rate between the years 1982 and 2003. To the extent that in the investors gained a 23,000 return. However, after the year 2003 the company started to face challenges marketing most of their products such as the “House America”. In the year 2007 the company recorded a depreciation of $20 billion and a loss of over $1 million. This continued to worsen since delinquency rate by the end of 2007 was at 2.33% which was way above the industry average. Though Countrywide had recorded huge boom in the initial years due to the home loans that attracted many customers, it later faced huge challenges in its financial status mainly because it had started losing its public image in relation to ethics. The unethical financial instruments associated with the company were on the basis that it continued to issue loans to clients who could comfortably qualify for traditional loans. The company also retained loans intended for investment so that they would continue attracting huge interests in its favor and resulted to client loss and criticism.
CFC initial intention was ethical and greatly assisted the American market in gaining housing loans. This resulted to the housing boom which assisted even the low income earners to gain access to home loans. Since the Countrywide granted loans with high risky levels on the lender their loans attracted higher interest rate to counter the risk. These loans were commonly known as Subprime loans since they did not follow the strict lending guidelines. Initially Countrywide products were a huge success and most people and institution thought it could mark the end of predatory lending. Instead it highly increased predatory lending and this was also the reason behind the downward trend of the company. Due to the high desire of the company to increase sales and number of credits, it allowed its sales agents to engage in lending’s which were too risk than what had been initially stated in the company lending guidelines. As a result even clients who could afford traditional lending facilities were awarded Subprime loans meant for the low income earners. The move was unethical in that the citizens that were supposed to benefit from subprime lending industry could not do so since the moderate and higher income earners flooded the industry. Further, the operations of Countrywide were unethical since it mainly concentrated on monitoring the high interest rate on loans even in situations where the risk levels on the lender were not too high.
The first step that the Bank of America should do to improve the financial status of Countrywide as a lending company is to improve its public image though looking at ethical issues. Since Countrywide downfall was greatly related to unethical behavior of its employees’, the bank should fire or at least cut all associations with stakeholders who were considered to be unethical. Further, the Bank should revise and place strict guidelines on their lending conditions and terms. This will ensure that only those that are supposed to benefit from the Subprime lending and those that cannot access traditional loans benefit from the Countrywide company program.